Reverse Mortgage vs Annuity: Which Retirement Product is Right for You?
By: Courtney Jorstad
September 26, 2023 • 10 minute read
One of the biggest concerns that retirees have is whether or not their retirement savings will be enough to last them throughout their retirement.
This uncertainty leads many to start looking to other options beyond their retirement savings accounts in search of greater financial security.
Two popular options are reverse mortgages and annuities. In this article, we will explore what these two financial products are, how they work, and who is a good candidate for each.
Understanding Reverse Mortgages
A reverse mortgage, also known as a Home Equity Conversion Mortgage (HECM), functions similarly to a traditional mortgage or a home equity loan. However, there are significant differences in how it operates.
When you opt for a reverse mortgage, it will settle your existing mortgage if your home is not yet fully paid off. As a result, you will no longer be required to make monthly payments towards your original mortgage.
Furthermore, the reverse mortgage loan will transform your remaining equity into cash. You have the flexibility to receive the funds as a lump sum, monthly payments, a line of credit, or a combination of these options.
For older homeowners that choose to receive their funds as monthly installments, they have the choice between term payments or tenure payments. Term payments are paid out for a fixed number of years. Tenure payments are paid out as long as the borrower has the reverse mortgage.
Unlike a traditional mortgage, a reverse mortgage does not necessitate monthly payments. Instead, repayment occurs when the home is sold, when it is no longer the primary residence, or upon the passing of the last homeowner.
A reverse mortgage can help with cash flow in two ways: eliminating monthly mortgage payments and giving borrowers access to additional cash in the method that they choose to receive it.
HECM reverse mortgages are backed by the Federal Housing Administration (FHA) and regulated by the U.S. Department of Housing and Urban Development (HUD). The backing of these two federal agencies ensures that homeowners receive several protections.
For example, one protection that comes with a federally backed HECM loan is that they are non-recourse loans. This means that when it comes time to pay back the loan, homeowners never have to pay more than what the home is worth.
There are two other types of reverse mortgages: single-purpose reverse mortgages and proprietary reverse mortgages.
As the name implies, single purpose reverse mortgages can only be used for a single, approved use, and they are typically obtained through the government. Proprietary reverse mortgages are typically jumbo reverse mortgages offered by reverse mortgage lenders. The FHA puts a lending limit on how much homeowners may borrow from a reverse mortgage; a jumbo reverse mortgage allows homeowners to borrow more than this lending limit.
Reverse Mortgage Requirements
To qualify for a reverse mortgage, specific requirements must be met, including the following:
- At least one homeowner must be 62 years or older.
- The home must be paid off or have equity built up in the home.
- The home must be in a good, maintained condition.
- Homeowners must be current on property taxes and homeowners’ insurance.
- Homeowners must also keep up on any other required fees such as HOA fees.
Before applying for a reverse mortgage, homeowners must complete a counseling session with a HUD-approved counselor.
After obtaining the reverse mortgage, borrowers must continue to maintain the home, pay property taxes, and homeowners’ insurance.
What a Reverse Mortgage Can Be Used For
One of the advantages of a reverse mortgage is that there are no rules about how it has to be used, giving homeowners a lot of flexibility.
That being said, here are some common ways that retirees use reverse mortgage proceeds:
- Enhance Retirement Portfolio. While a reverse mortgage used to be considered a last resort option, retirement experts now argue that a reverse mortgage is best used earlier on as part of the overall retirement plan. For example, if you are retiring during a market downturn, you can rely on the funds from a reverse mortgage to cover your bills before you feel comfortable tapping into your retirement savings accounts.
- Supplement Income. If your monthly income from Social Security, pensions, and your 401(k) isn’t enough to cover your costs, a reverse mortgage can provide additional monthly income if you choose to receive the funds as monthly installments.
- Home Renovations. If you want to update your home for better retirement living but lack the necessary savings, receiving a lump sum or line of credit from a reverse mortgage can help cover the costs of the home repairs and potentially increase your home’s value.
- Unplanned Expenses. If you don’t have substantial savings for unexpected expenses, opting for a reverse mortgage line of credit ensures that funds are available when needed. One of the perks of the reverse mortgage line of credit is that the untouched balance actually grows.
- Credit Card Debt. A reverse mortgage can also be used to pay off credit card debt or debt incurred from medical expenses.
- Enjoy Your Dream Retirement. If you have enough income to cover your monthly expenses, but you don’t feel like you have enough money to travel the way you wanted or visit your grandchildren as often as you would like, a reverse mortgage may help make these things possible.
Who is a Good Candidate for a Reverse Mortgage?
Those who are considered good candidates for a reverse mortgage are individuals who meet the following criteria:
- They are at least 62 years of age.
- They own a home
- The home is their primary residence
- They have equity built up in that home
An annuity is another financial product that can help supplement income in retirement. An annuity is an insurance contract that is purchased by investors in exchange for a guaranteed payout either right away or later in the person’s life.
Annuities can be purchased with monthly premiums or with a lump sum premium. Some annuities provide a way to save for retirement in the future. Other annuities take money you currently have saved up and convert it into an income stream that can be used right away. Some annuities provide both options.
Likewise, the money received from annuities come in the form of monthly payments or a lump sum amount.
One of the reasons that investors like annuities is because they come with a guaranteed payout, and it’s a way to invest in the stock market with minimal risk.
All annuities are regulated by state insurance commissioners around the country. The U.S. Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) regulate variable annuities and registered indexed-linked annuities (RILAs).
Types of Annuities
Annuities typically fall under two categories: immediate annuities and deferred annuities. Here is a breakdown of what these two types of annuities are and how they work.
An immediate annuity allows investors to start receiving payouts right away. Payouts can be fixed or variable. Fixed annuities are considered to come with a lower risk than variable annuities.
Immediate annuities may be a good option for someone who has just received a large sum of money from something like an inheritance, a settlement, or the lottery. They may want to make sure that they don’t spend all their money at once, so they put it in an annuity to ensure they receive a regular income from their funds.
As the name implies, a deferred annuity will provide funds to you at a future date. Just like immediate annuities, deferred annuities can also be fixed or variable. With a deferred annuity, investors make a lump sum payment, and then the insurance company provides a payout for life or a fixed period. The annuity payments can happen monthly, quarterly, or annually.
If someone opts for a deferred annuity, they will decide on the age at which they want the payments to begin.
There are also several variations within these two categories including a hybrid annuity called indexed annuities, also known as equity-indexed annuities or fixed-index annuities.
How Annuities Work
Annuities are typically broken up into periods:
- Surrender Period/Accumulation Phase. The surrender period is when payments are made into the annuity and money starts to build up. Investors are unable to touch the money during the phase. If you opt for variable annuities, you will be allowed to put a portion of the money into a fixed-interest rate account.
- Payout Phase/Annuitization Phase. This is when investors start receiving their payments.
Similar to reverse mortgages, the money from an annuity can also be used however the investor sees fit. In most cases, they are used to supplement retirement income.
Who are Annuities for?
Annuities are typically purchased to help those in retirement manage their income. An annuity is sometimes viewed as a way to “insure” retirement savings, first by guaranteeing that you will receive a regular payment as long as you live, similar to a paycheck.
However, because the money that is put into an annuity is “illiquid,” it is not recommended for younger investors who may want to tap into the money before the payout phase begins.
Reverse Mortgage vs Annuity: Which One is the Better Option?
Whether you decide to go for a reverse mortgage, or an annuity will depend on a variety of factors.
First, if you own a home and have significant equity built up, a reverse mortgage may make more sense. If you have a large sum of money that you want to insure won’t get spent all at once, but will provide a consistent income stream, then an annuity may make more sense.
If you have several years until you expect your retirement to start and have time to start putting money into an annuity that you will receive money from years later, then investing in annuity may make sense.
If you are near or in retirement and you need the money more immediately, then a reverse mortgage may make more sense.
Taxes: Reverse Mortgage vs Annuity
One advantage to a reverse mortgage is that there are no taxes required on the money that borrowers receive. This is because a reverse mortgage is a loan, so it’s not considered income.
There are tax obligations that have to be paid on annuities. There are no taxes paid on annuities during the accumulation phase. Taxes are only required when investors start withdrawing money from their accounts. The tax rate on annuities is the same as income taxes.
Fees: Reverse Mortgage vs Annuity
Another factor to consider with these two options is fees.
When it comes to annuities, investors will have to pay a penalty fee if they decide to withdraw money from the account during the surrender phase. Most insurance companies also charge an annual fee that goes to the company.
In addition, one of the costs of an annuity is the commission that goes to the insurance broker. Commissions can range from one percent to 10 percent depending on the type of annuity.
Other annuities fees may include mortality expenses, the investment expense ratio, and rider fees.
Reverse mortgages also come with several fees: closing costs, the first mortgage insurance premium, and the origination fee. Lenders are not obligated to charge an origination fee, but if they do, the federal government caps how much lenders can charge for its origination fees, which currently can’t be more than $6,000.
To learn about the fees you can expect to pay with a reverse mortgage, we recommend talking to a reverse mortgage lender. Find our featured reverse mortgage lenders here.
Reverse Mortgage vs Annuity: FAQs
Technically, a reverse mortgage can be used for anything you want, so yes it could be used to purchase an annuity. That being said, several financial experts recommend that consumers avoid working with anyone who is encouraging you to get a reverse mortgage so you can invest it in an annuity or any other financial product
Both annuities and reverse mortgages are regulated by the federal government, which helps to protect borrowers and investors.
Get answers to more of your reverse mortgage questions here!
The Bottom Line
Ultimately, the right choice depends on individual circumstances and financial goals. It’s recommended to consult with a financial advisor to determine which option is best suited for your specific needs.
If you are ready to move forward, the next step is to get started by reaching out to a reverse mortgage lender or insurance company that offers annuities.
This information is intended to be general and educational in nature and should not be construed as financial advice. Consult your financial advisor before implementing financial strategies for your retirement.